USD: Tightrope walk for the dollar – Commerzbank

The coming weeks, and probably even months, are likely to be a tightrope walk for the dollar against the backdrop of the Fed's adjusted stance. Our economists had been expecting interest rate cuts in September and December for some time, precisely because they anticipated that the FOMC and Fed Chair Jerome Powell would attempt to ease political pressure to a certain extent by lowering interest rates moderately. In this respect, our experts are not particularly surprised by Powell's change of tone at the Jackson Hole conference, Commerzbank's FX analyst Antje Praefcke notes.

Times might remain difficult and volatile for the dollar

"Powell obviously had to present valid arguments for possible interest rate cuts. And since the upside risks to inflation from US tariffs are definitely present, but it will only become clear in a few months whether the effect will really be temporary as expected, he had to focus more on the downside risks to the economy and the labor market. Therefore, the risks for the dollar will remain asymmetrically distributed. If the economy and labor market remain robust and the tariff effect on inflation is temporary, there may be fewer interest rate cuts than the market expects. In this case, an upward correction in the dollar, as we saw last week, would be entirely possible. However, the downside risks for the dollar dominate. Weaker economic data would cement or even reinforce expectations of interest rate cuts, for instance in the direction of one or more 50 basis point moves. This would weigh on the dollar."

"If, on the other hand, economic data remains relatively solid, but inflation and, above all, inflation expectations pick up, while the Fed continues to sound dovish, the Fed's response function of reacting 'appropriately' to inflation risks could be called into question. This, in turn, would also be viewed negatively by the market for the dollar. After all, a central bank should respond appropriately to inflation risks with its monetary policy, otherwise the currency will be punished. An impressive example of this is the Turkish lira."

"As difficult as it is for Powell to navigate between 'correct' monetary policy requirements and political demands, times will remain difficult and volatile for the dollar. In particular, most developments are likely to be interpreted negatively. I cannot currently think of a scenario in which the dollar suddenly appreciates massively and regains its 'old strength' (also because of structural factors – think of the discussion about the independence of the Fed, which has gained momentum again with the affair surrounding Governor Lisa Cook, or the fiscal position of the US, which will deteriorate with Trump's plans). But then again, no one could have imagined a pandemic either."